Monday 20 May 2019

Refusing credit will turn our problem into a crisis

DON'T ask for credit as a refusal often offends. The warning used to be quite common in the days when the shop was often a lender of last resort.

It is less common now – although probably making a comeback, but Michael Noonan may find its equivalent in the window when he next visits Unter den Linden – or a few other government seats in Europe.

That appears to be the position regarding a "backstop" loan facility for Ireland as it prepares to exit the bailout and take its first full, faltering steps in the market for government bonds. It is, to put it mildly, an extraordinary state of affairs.

The proper name for the backstop is "precautionary credit line". The key word is "precautionary". If things go wrong in the first 12 months, and Ireland cannot borrow what it needs on the market, the funds would be made available, rather than negotiating a new emergency bailout.

They could be extended for a further 12 months, subject to agreement. This is the period of most interest to both the Government and the markets. Famously, or infamously, the National Treasury Management Agency (NTMA) built its own backstop, with borrowings of €25bn, even while the country was still under the troika.

One says "infamously" because some analysts have criticised the cost of this backstop. At a 4pc rate of interest, the annual bill would be €600m. Whatever the precise amount, it is a lot of money, especially in light of the difficulties in framing last week's Budget.

I would have been inclined to join the critics, on the grounds that this really seemed to be girding on both belt and braces. There is enough cash in the kitty to allow the NTMA stay largely out of the market next year – which is one big reason why 2015 is of more interest to the Irish authorities.

But I did not imagine there would be difficulties over the backstop. One thought the ramshackle political architecture of the eurozone could no longer surprise, but this is more than a surprise; it is astonishing.

It is true that this show is not over until a certain lady sings. It is also true that formal negotiations have still to get fully under way. Perhaps reason will prevail, but the fact that there is any doubt over the matter show how very deep the hole is which European leaders have dug for themselves.

It goes without saying that a successful return to the markets by Ireland is critical to the future of the euro. It therefore seems obvious that Ireland should be assisted on its way: not out of kindness to Ireland but in the sheer self-interest of the lending countries, headed by Germany. Yet, incredibly, that is where the objections come from.

The only gloss which can be put on this example of blazing away at one's own feet is that a "clean" return by Ireland to the markets would be so much more impressive and persuasive. A failed re-entry will be far more damaging than a clean one will be helpful.

Why should there be difficulty over sensible precautions? The facility would not be available to cover slippage in Irish budget deficits but could be called upon to cope with a general market shock, or new difficulties in the Irish banking system.

There, perhaps, is the nub. Last week's formal report to the federal government from the leading German economic institutes shows the fear about covering the losses of banks in other countries – and also the muddle and confusion which fear can engender in even the sharpest of minds.

Having noted Ireland's progress, the institutes, quite correctly, also noted the country's high debt and weak banks as leaving it vulnerable to domestic and external shocks.

Precisely. One can envisage shocks on a scale which would fatally undermine Ireland's return to the markets. But one can also envisage shocks which it could survive with the temporary assistance of a backstop loan. If it is not in place, the whole bailout business would start again, in yet another example of the eurozone turning a problem into a major crisis, for want of timely action.

Not only is there is a reluctance to do "whatever it takes" to maximise the chances of Ireland returning to the markets; there seems a reluctance to do anything at all. Some market observers are lining this to the origin of that phrase – the European Central Bank's OMT scheme (Open Market Transactions) which would put a ceiling on government interest costs in certain circumstances.

The promise of OMT has been credited with ending the acute euro crisis. It has not yet been tried and no one knows what the certain circumstances might be, or what conditions a government would have to accept in return for OMT support. But if it is not rolled out for Ireland's exit from the bailout, the suspicion is bound to grow that it will never be rolled out at all.

The most likely explanation for all this confusion is that, once again, future problems are messing up the willingness to deal with current ones.

The next big issue is the testing of eurozone banks and the sharing of losses and provision of capital for those found wanting. It is widely believed that junior bondholders – at the very least – will have to take losses, as they did in Greece, Cyprus and even Anglo Irish.

It is even more widely believed that there will be no direct EU capital for troubled banks to cover remaining losses. This makes it clear why Ireland is making no headway in trying to secure such capital for its banks. The precedent is just too dangerous.

The probability is that European banks will be only partially tested and partially refinanced to spare taxpayers outside their home countries from having to take on more debt to fully refinance them.

In theory, none of that applies to the precautionary credit. In practice, it seems to be having a wholly baleful effect.

Behind that, in turn, lies the basic feeling in the creditor countries that the indebted ones cannot be trusted to do the right thing – a feeling alluded to by the head of the Berlin DIW institute.

It is the case that relations between countries are based, not on trust, but on mutual interest. In the end, if it is to succeed, the eurozone countries will have to replace that with the kind of pragmatic trust found within political entities. In this case, though, even mutual interest appears to call for a change of stance.

Irish Independent

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